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Canadian & New Zealand Dollars Outperform US and Austrailian Counterparts

The cointegrated spread between the CAD.USD and the AUD.NZD has widened today and is nearing a potential entry point. The spread is now 1.7 standard deviations from its mean. In order to bet on the spread to decline, one would need to execute the following two trades: Sell the CAD.USD and Buy the AUD.NZD. The amount of AUD.NZD purchased should equal 72% of the amount of CAD.USD sold. Currently, the trade is expected to make 3.1% if the spread regressed back to its average.

Cointegrated Forex Baskets

I track forex cointegration statistics on a weekly and daily basis. Here is a listing of the highest cointegrated pairs and their current normal distribution Z-score. As of Sunday night there were not any trades that exceeded two standard deviations so I am off on the sidelines. I'm watching the CHFUSD/GBPCHF and the CADUSD/AUDNZD combos closely as trading during the week progresses. More on these cointegration statistics later.

KST Indicator for ThinkOrSwim

The Know Sure Thing (KST) indicator made famous by Martin Pring is now here free and ready to be used with ThinkOrSwim software.  Feel free to copy the code below and use it however you see fit.















# Martin Pring's KNOW SURE THING (KST) Indicator
# Daily KST Simple Moving Average
# Writen by Mike Wilgus
# fxmike.blogspot.com
# ------------------------------------------------
declare lower;

#--Input variables
input rocLength1 = 10;
input rocLength2 = 15;
input rocLength3 = 20;
input rocLength4 = 30;

def sumRocLength = rocLength1+rocLength2+rocLength3+rocLength4;
def avgLength1 = 10;
def avgLength2 = 10;
def avgLength3 = 10;
def avgLength4 = 15;


#--Calc ROC - RateOfChange(length, color norm length, price)
def ROC1 = RateOfChange(rocLength1, rocLength1, close);
def ROC2 = RateOfChange(rocLength2, rocLength2, close);
def ROC3 = RateOfChange(rocLength3, rocLength3, close);
def ROC4 = RateOfChange(rocLength4, rocLength4, close);

#--Plot lines
plot zeroLine = 0;

plot fastKST = (Average(ROC1,avgLength1)*(rocLength1/sumRocLength))+
               (Average(ROC2,avgLength2)*(rocLength2/sumRocLength))+
               (Average(ROC3,avgLength3)*(rocLength3/sumRocLength))+
               (Average(ROC4,avgLength4)*(rocLength4/sumRocLength));

plot slowKST = Average(fastKST,rocLength1);


#--Set Colors and Style
zeroLine.SetDefaultColor(GetColor(7));
fastKST.SetDefaultColor(GetColor(5));
fastKST.SetStyle(Curve.LONG_DASH);
slowKST.SetDefaultColor(GetColor(1));


#--End Code--------------------------------------

USDJPY Fibs

The July 13 - August 7 rally in the USD/JPY pair that broke through a previous downtrending channel to the upside corrected at the 62% fibonacci as measured from the May 6 high. Interestingly this latest downturn has taken a bullish turn after retracing 62% from it's short term peak on August 7.

There have been bullish USD/JPY commentary from Forex.com as reported by bloomberg recently as well.

USD/JPY Fundamentals

I have compared Japanese trade balance data with the USD/JPY exchange rate to determine that the dollar could appreciate as much as eight cents in the next eight months.

USD/JPY exchange rate

Japanese exports and imports are both down, like the rest of the world.

Japanese trade balance (imports minus exports) turned signifcantly negative during December and January. This caused Japan to become a net importer during the worst of the global recession.

Trade numbers take a little while to work themselves into the exchange rate. I lagged the USD/JPY by 10 months and compared it to a 3 month average of Japanese trade balances. The results are depicted. The correlation is better than 83%.

Throughout 2008 and 2009, the correlation between USD/JPY exchange rates and Japanese trade balances has been positive.

Three month average trade balance is significant against the exchange rate at the 1% level. The regresion reveals the following equation.

USD/JPY = 109.126 + 0.00001498 * Trade Balance 3 Month Moving Average

Using this equation, excel calculated predicted what the USD/JPY exchange rate would be 10 months after the recorded trade balance.

The model explains 69% of the exchange rate movement so there are some errors to deal with. The residuals use USD/JPY exchange rates 10 months after the observed trade balance figure. They are calculated as Actual exchange rate - Predicted exchange rate. The results show that, as of July, the USD/JPY is the most undervalued iti has been since the begining of 2008.

Inflation Expectations Ahead of FOMC Meeting

Inflation expectations are above 1.92 again. Look for the Fed to bring an end to all their bond purchases.

New Correlation Charts

Here is how to read these charts which measure correlations and potentially profitable hedged carry trades. Daily periodic returns are the percent change (natural log) of the currency as per daily New York close.

The first chart measures the correlation between the DPR of 23 tradable currencies on FXCM. The bottom chart measures the correlation in the prices of the currencies. If the price is rising, a strong positive correlation will mean the other currency's price will rise as well. The middle chart displays how much interest will be earned if a trader takes positions in each of the corresponding currencies. If the correlations and interest rate swaps are positive, you can buy on pair and sell the other. Price appreciation (depreciation) will average zero and you are free to earn interest at FX leverage rates.

Currently, I am long AUD/USD and short EUR/USD. The AUD/JPY and CHF/JPY pair looks attractive right now and I may be adding that soon.

Positve Supply Shocks

A quick reminder about the macro environment: Positive supply shocks are characterized by lower prices and higher quantities demanded. They can be caused by lower input costs.

Year over Year Eurozone PPI numbers are down over 6%.

An old San Fransisco Fed article instructs us to focus on nominal GDP (or spending) to get a handle on inflation during positive supply shocks.

Hedging a Breakout

Selling the EUR/JPY breakout would have been an effective and profitable hedge against the NZD/USD and GBP/USD breakouts early in the Tokyo session today. All three breakouts to the upside failed and ended up costing me. It was apparent that the Euro was the weakest of the major currencies. Next time I will look to hedge my breakout plays with a long-reversal on the weak currency.

Long the breakout

Short the breakout

British Stagflation

High Prices

High CPI

Currency devaluation

Expansionary Monetary Policy

125 Billion Pound asset purchase

0.50% Bank of England rate

What to watch out for

Increasing wages

Imports

New taxes

Euro, Frank Weakness Ahead

Trading ranges from Friday were tight so I am hoping for some break outs early on Sunday in the east coast. The Euro and Frank Yen pairs are begining the week in a bad position and I am looking for them to follow the path of the dollar from last week.

More Yen Strength to Come

Heading into the Tokyo open the Yen is strong while the Euro and Aussie are notably weak. Currencies were slow tuesday as the equity markets sold off and came dangerously close to signally a bearish downturn. Wednesday in the Currency market may be a repeat of Monday with a big flight to quality. The Yen and US Dollar will be strong.

Potential Trouble in US Equities

The the GBPJPY is 95% correlated with the S&P 500 over the last five years, and the currency pair just tanked after completing the same head and shoulders pattern that the US stock market is setting up for. S&P 500 futures have been bad since the market opened this week and will likely be bad all day today, Monday.

The USD/JPY used to be highly correlated to the US stock market as borrowers would borrow money to buy US stocks, or deleverage and sell US stocks. That correlation broke down when the US Fed dropped it's interest rate to 0-0.25%. There was no reason to to buy the USD/JPY when the GBP/JPY still returned a healthy margin. The GBP/JPY correlation should hold as long as the Bank of England doesn't interfere. They do have rate decisions and a lot of economic data coming out, so the GBP/SPY correlation should be monitored closely

Faster Than Bloomberg

I've been buying Yen all throughout the Asian session. I covered my Sterling bet and got short the dollar as the Western European markets are about to open. They are all waking up to a lovely piece titled "Yen Advances Verses Euro on Concern Credit Losses Increasing" (Bloomberg)

GBP/JPY Breaks Down

The Japanese sold the pound aggressively at the open in Tokyo. The Pound was driven below it's seven day low against the yen. I put this sell on a couple of hours ago. The play is similar to the Kiwi short that I posted a short while ago. While the kiwi drifted back up to the 20 EMA and I covered, the GBP continues to be weak. The ICH on the 30 minute chart is also providing some downward pressure on the GBP/JPY and that may be helping my new position.

In equity news, the S&P 500 futures are pointing to a lower open. The futures are trading 90 points above the 880 level that would confirm a head and shoulders topping pattern.

Economic Events

Tuesday
AUD Interest rate decision @ 4:30 - Predicted to remain at 3.00%
GBP June GDP estimate @ 23:00 - Previously -0.9%

Wednesday
EUR Q1 GDP estimate @ 9:00 - Previously -2.5%

Thursday
AUD Employment @ 1:30 - Previously -1.7K
GBP BoE rate decision @ 11:00 - Expected to remain at 0.5%
CAD Housing starts @ 12:30

Friday
CAD Employment @ 11:00 - Previously -41.8K

Times are GMT. (DailyFX)

Sell Kiwi on the Open

The NZD/USD opened weak in Sydney. The price is trading between the second and first bollinger band and below the previous days low. I'm putting on a short with a stop at the 20 period EMA.

Developments

As a weak stock market could be a cue to buy dollars, a strong stock market can be a dollar killer. My USD/CAD and USD/EUR positions pulled back as the S&P moved higher. The USD/CAD was due for a move dow; I was expecting it and I had tighted my stops just last night. The AUD/USD is showing some relative weakness, however, even though their retail sales were better than expected. More investigation is required about the Aussie.

Apparently the Euro is correlated to higher makrets; I'll have to look at this. (Bloomberg)

Sell EUR/USD

I added a short EUR/USD position to my portfolio and will use that as my primary AUD/USD hedge. The USD/CAD is still open and I'm riding it until it falls out of it's channel. I have my stop placed just under the monthly 50 day moving average, or at 75% of my gains.

The EUR/USD price is 96% correlated to the AUD/USD and the periodic returns are 66% correlated. One day VaR at 0.1% is about $350. I'm holding enough excess margin for two of these but I'm going to hold off expanding for now.

Green line means long, red means short.